CFTC continues trend of holding financial institutions responsible for customers’ financial crimes

It is axiomatic in the financial crime DNA that a financial institution is an indispensable component. Regulatory agencies and victims of financial crime know this and, in recent years, have begun focusing on the actions, inaction and, sometimes, complicity of institution insiders in the commission or cover-up of the crime or laundering of its proceeds.

The Commodity Futures Trading Commission seems to have taken that notion to heart. In a suit filed in federal court in Cedar Falls, Iowa last month, the CFTC sued US Bank, NA for its role in the 2012 collapse of Iowa-based futures brokerage Peregrine Financial Group, Inc. It alleged that the bank knowingly mishandled Peregrine client funds and enabled former Peregrine owner and founder Russell Wasendorf, Sr. to defraud 24,000 Peregrine customers of about $200 million. Wasendorf has been called the “Midwest Madoff” as a result.

CEO’s fraud, embezzlement and more led to Peregrine’s massive collapse

The CFTC suit is the latest chapter in the bizarre Peregrine saga. It began in July 2012 when Wasendorf, a well-known businessman in Cedar Falls, attempted suicide and left a note admitting to sacking his company for 20 years. The CFTC promptly sued Peregrine and Wasendorf for misappropriating customer funds. Peregrine filed for bankruptcy hours later and its stunning, rapid collapse made worldwide headlines.

Faced with insufficient corporate assets to recompense Wasendorf’s victims, the CFTC is now looking at US Bank to contribute handsomely to the restitution. The regulatory agency asks the Iowa federal court to declare that US Bank violated the Commodity Exchange Act (Title 7, USC Section 6d (b) and its regulations (17 CFR Section 1, etc.).

It also asks that the court order the bank to “make full restitution” to all Peregrine customers whose funds Wasendorf held in a special account at the bank with Peregrine customer funds, which he, his wife, Connie, and their construction company used as a slush fund for personal expenses and their side businesses. The CFTC also asks the court to order the bank to “disgorge” any funds that it derived from its banking relationship with Peregrine and Wasendorf.

Perhaps most financially ominous, the agency asks for the imposition of a “civil monetary penalty” equal to three times the bank’s “monetary gain” or for imposition of a penalty ranging between $130,000 and $140,000 “for each violation” committed after October 2004 until the fraud collapsed in 2012.

A calculator with a widescreen would be required to total the monetary penalties these requests may produce.

CFTC says US Bank knew Peregrine customer funds were being diverted

Wasendorf, who survived his suicide attempt, was sentenced in September 2012 to 50 years in prison and ordered to pay more than $215 million in restitution. He had been charged with federal crimes of fraud, embezzlement, and making false statements.

As the criminal case against Wasendorf drew to a close, concerns about US Bank’s involvement in the fraud came to light. A civil suit filed in September 2012 by Wasendorf, Sr.’s son, who was Peregrine’s president at the time the fraud imploded, alleged that US Bank was aware his father’s crimes while it did business with Wasendorf, Jr. Although this suit was dismissed in October, the allegations it brought to light proved ominous for US Bank.

The CFTC suit says US Bank improperly held and used Peregrine’s customer funds. It alleges that “neither U.S. Bank nor Peregrine was permitted to ‘hold, dispose of, or use’ these customer funds as though they belonged to anyone other than Peregrine’s customers.”

The complaint alleges two principal areas of misconduct by the bank:

  • It held and used Peregrine’s customer funds as security on personal loans it made to Russell Wasendorf, Sr., his wife, and their construction company to construct an office building complex where Peregrine was the primary tenant.
  • It held Peregrine customer funds in an account the bank treated as if it were Peregrine’s commercial checking account and knowingly allowed and facilitated Wasendorf transfers of customer funds out of this account to pay for a private airplane, restaurant and his divorce settlement, among other things. The CFTC alleges the bank knew that these transactions were not for the benefit of Peregrine customers.

The complaint says the bank and Peregrine Financial did business together for nearly 20 years, but the CFTC case only focuses on the actions that took place from 2008 to 2012.

Handling of “customer segregated accounts” is at issue

The case hinges on the designation of the mishandled Peregrine accounts as repositories for the firm’s “customer segregated funds.”

As a “Futures Commission Merchant,” or FCM, Peregrine received funds from its customers to margin, guarantee or secure customer futures and options trades. Under the law, Peregrine was required to keep these customer funds separately from other funds to assure they are protected and available for immediate withdrawal or transfer at the option of the customer or in case Peregrine had financial difficulties. In an eight year period, Peregrine deposited with US Bank about $308 million in what the CFTC calls “customer segregated funds.”

The CFTC alleges US Bank “allowed Wasendorf to limit access to, and information about, an account holding millions of dollars of Peregrine’s customer funds to only Wasendorf” in violation of regulations governing customer segregated accounts. Wasendorf required the bank to direct all communications to him regarding the slush fund account, which was called “1845 account.”

US Bank allegedly “entrusted primary responsibility for managing its relationship with Wasendorf and Peregrine to an unnamed ‘Assistant Relationship Manager.’” In its internal computer system, the bank placed special notes on the 1845 account to indicate to employees that no account balance confirmations on the account were permitted, and that all inquiries on the account should be routed to the unnamed banker or another “Relationship Manager.”

The suit says that banker knew that the funds in the 1845 account were subject to “segregation requirements” but still “personally facilitated telephonic and in-branch deposits and wire transfers of Peregrine customer funds into and out of the 1845 Account” for Wasendorf.

In a prepared statement, US Bank said it was “a victim of the same fraud.” It added, “The bank did nothing wrong and the bank will defend itself vigorously…. The lawsuit itself accuses the bank of violating technical regulations that have never been interpreted by any Court to apply when a bank is not notified that it was holding Customer Segregated Funds.”

CFTC seems to be toothless no more and financial institutions will take note

The CFTC, long considered one of the weakest federal financial regulatory agencies, has consistently ramped up its enforcement actions since enactment of the Dodd-Frank Act in 2010. That far-reaching law empowered the agency and enhanced its authority. During Fiscal Year 2012, the CFTC filed 102 enforcement actions and levied $585 million in penalties – $450 million more than the previous year.

The US Bank statement says, “Banks are not responsible for losses generated by customers who are fraudsters.” Recent successful lawsuits by financial crime victims against banks for complicity or negligence in detecting or halting the financial crimes committed by their customers indicate that this assertion by US Bank is losing credence each day.

Read the CFTC’s complaint against US Bank here